Mining - Gold Stock Outlook: Trade War Fears & Asia Catalysts

Trade war apprehensions due to the ongoing imbroglio between the United States and China have supported gold prices lately. However, strength in the U.S. dollar, rising U.S. Treasury yields and robust manufacturing data have weighed on gold prices.

The Federal Reserve has hiked interest rates by 25 basis points to a range of 1.75-2.00%, and signaled two more hikes this year. Higher U.S. rates raise the opportunity cost of holding non-yielding bullion and normally weigh on gold.

Nevertheless, major markets India and China will continue to be growth drivers. The second half of the year is seasonally strong in India due to the festive and wedding season buying. The United States continues to be a strong market on the back of economic growth and improving employment levels.

Demands from central banks also remain robust with Turkish and Russian central banks, adding to their gold reserves. Further, gold is witnessing increased requirement in technology, bolstered by demand for high-end smartphones after years of decline.

Industry Lags on Shareholder Returns

Looking at shareholder returns over the past year, it is quite apparent that investors' confidence on the industry's prospects is not as anticipated despite geopolitical issues. Even though a small number of major projects came online at the end of 2017, the project pipeline remains weak and production development expenditure remains at multi-year lows.

Though production is anticipated to pick up this year and next, global mine production levels are expected to decline eventually. Further, prospects of a rate hike kept the industry under pressure.

The Zacks Mining - Gold Industry , which is a 33-stock group within the broader Zacks Basic Materials Sector , has underperformed both the S&P 500 and its own sector over the past year.

While the stocks in this industry have collectively declined 4.4%, the Zacks S&P 500 Composite and Zacks Basic Material Sector have rallied 13.9% and 19.3%, respectively.

One-Year Price Performance

Gold Mining Stocks Trading Cheap

Owing to the underperformance of the industry over the past year, the valuation looks really cheap now. One might get a good sense of the industry's relative valuation by looking at its Enterprise Value to Earnings before Interest Depreciation and Amortization (EV/EBITDA).

This valuation is a good measure for the industry's given its complicated and capital-intensive nature. It helps investors compare gold mining companies with various capital structures and gives a more accurate feel of the financial health of a miner as well as whether it is undervalued in comparison with its peers.

The industry currently has a trailing 12-month EV/EBITDA ratio of 8.3, which when compared with the highest level of 11.8 over the last five years and five-year median level of 7.7, reflects the fact that there is more room to run.

The space also looks inexpensive when compared with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.6 and the median level is 9.8.

EV/EBITDA Ratio (TTM) Comparison with S&P 500

A comparison of the group's EV/EBITDA ratio with that of its broader sector ensures that the group is trading at a decent discount. The Zacks Basic Material Sector's trailing 12-month EV/EBITDA ratio of 10.3 is way above the Zacks Mining - Gold Industry's EV/EBITDA ratio of 8.3.

EV/EBITDA Ratio (TTM) Comparison with Sector

Underperformance May Continue Due to Bleak Earnings Outlook

The expanding middle class in China and India, combined with broader economic growth, will have a significant impact on gold demand while the ongoing geopolitical tension should support gold prices, helping the gold mining industry to generate positive shareholder returns in the near future.

However, what really matters to investors is whether this group has the potential to outperform the broader market in the quarters ahead. While the above ratio analysis shows that there is a solid value-oriented path ahead, one should not really consider the current price levels as good entry points unless there are convincing reasons to predict a rebound in the near term.

One reliable measure that can help investors understand the industry's prospects for a solid price performance is the earnings outlook for its member companies. Empirical research shows that a company's earnings outlook significantly influences the performance of its stock.

One could get a good sense of a company's earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year's reported number. However, an effective measure could be the magnitude and direction of the recent change in earnings estimates.

The consensus earnings estimate for the Zacks Mining-Gold industry of 46 cents per share indicates a year-over-year decline of 11.5%. Further, the trend in earnings estimate revisions has not been favorable lately.

Price and Consensus: Zacks Mining - Gold industry

Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group's earnings potential.

The consensus EPS estimate for the current fiscal year has been revised 14.8% downward since Mar 31, 2018.

Current Fiscal Year EPS Estimate Revisions

Zacks Industry Rank Indicates Upbeat Prospects

The group's Zacks Industry Rank , which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.

The Zacks Mining - Gold industry currently carries a Zacks Industry Rank #102, which places it at the top 40% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Gold Miners Lags in Long-Term Growth

The long-term (3-5 years) EPS growth estimate for the Zacks Mining - Gold industry has been increasing since April 2018 to reach the current level of 8%. This compares unfavorably with 9.8% for the Zacks S&P 500 composite.

Mean Estimate of Long-Term EPS Growth Rate

The basis of this long-terms EPS growth could be steady downward trend in the top line that gold miners have been experiencing over the past five years.

Moreover, a decline has been noted in EBITDA, which is a key element in valuation of gold mining stocks as mentioned earlier, despite a drop in costs.

Bottom Line

Rising geopolitical tensions will help prop up gold prices this year despite the prospect of two more rate hikes. India and China will continue to be growth drivers. Last year, the Indian market had suffered a setback due to the impact of imposition of Good and Service Tax ("GST") and anti-money laundering legislation ("AML") around jewelry retail transactions. It will bounce back as the market adapts to GST and pent-up demand as well as festive buying is anticipated to boost demand for jewelry in the country. The Indian government also announced measures to bolster rural incomes. This along with forecast for a normal monsoon bodes well the rural sector which is an important consumer for the gold industry.

Investors could take advantage of the cheap valuation and bet on a few gold mining stocks that have a strong earnings outlook.

While none of the stocks in our gold-mining banks universe currently sport a Zacks Rank #1 (Strong Buy), there are two stocks that carry a Zacks Rank #2 (Buy) and been witnessing positive earnings estimate revisions lately.

(You can see the complete list of today's Zacks #1 Rank stocks here .)

Alio Gold Inc. (ALO): The Zacks Consensus Estimate of this Vancover, Canada based gold miner for the current-year EPS has been revised upward by 3% over the last 60 days.

Price and Consensus: ALO

Kirkland Lake Gold Ltd. (KL): The Zacks Consensus Estimate for this Toronto, Canada-based driller gold miner for the current-year EPS has been revised upward by 6% over the last 60 days.

Price and Consensus: KL

Stocks to Stay Away From

Due to the short-term concerns related to Gold-Mining stocks, we suggest that you avoid two stocks as these have a Zacks Rank #4 (Sell). Both these stocks have witnessed negative earnings estimate revisions.

Harmony Gold Mining Company Ltd. (HMY): The consensus EPS estimate for this Randfontein, South Africa- based gold miner plunged 32% for the current fiscal year in the last 60 days.

Price and Consensus: HMY

NovaGold Resources Inc. (NG): The consensus EPS estimate for this Vancouver, Canada-based gold miner declined to a loss per share of 8 cents from 7 cents for the current fiscal year over the last 60 days.

Price and Consensus: NG

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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